Restructuring & Insolvency

Asia Pacific

CHINA
Law of the
People’s Republic of China
on Enterprise Bankruptcy

Introduction
Overview The bankruptcy regime was a major milestone for China. For the
first time in its history, China now has a unified and comprehensive
On 27 August 2006, the bankruptcy system covering all types of enterprises, including foreign
Standing Committee of investment vehicles and state-owned enterprises.
the 10th National People’s
Similar to many jurisdictions, the bankruptcy regime uses key concepts
Congress of the People’s
such as:
Republic of China (PRC)
promulgated the Law ƒƒ Voluntary and involuntary bankruptcy;
of the People’s Republic ƒƒ An independent administrator;
of China on Enterprise
ƒƒ Involvement of creditors in the administration of the bankruptcy;
Bankruptcy (Bankruptcy
Law), which came into ƒƒ Restructuring and settlement;
force on 1 June 2007. ƒƒ Extraterritoriality, allowing property outside China and certain
foreign proceedings to fall within the regime;
ƒƒ Voidable transactions; and
ƒƒ Ratable distribution.

A significant feature of the legislation relates to the protection of

workers’ rights. The regime ranks employees ahead of other unsecured
creditors but behind secured creditors, who retain their priority over
secured assets.
Applicable legislation
The Bankruptcy Law, which consists of 136
articles organized into 12 chapters, applies to
all types of insolvent enterprises, whether
state-owned or privately owned, and includes
foreign investment enterprises and financial
institutions. It does not apply to individual
natural persons.
The legislation only applies to PRC entities
although it extends beyond China’s borders
in relation to a debtor’s overseas properties.
The regime also recognises certain foreign
proceedings that seek to secure assets located
in China.
Personal bankruptcy
There has been no law passed governing
individual bankruptcy in China.
Corporate restructuring and insolvency
Court-based insolvencies
GROUNDS FOR BANKRUPTCY
The regime relies on an insolvency test as a
ground for bankruptcy. An enterprise will qualify
for bankruptcy, restructuring or settlement
under the Bankruptcy Law if the enterprise is
not able to meet its obligations to repay its
debts and its assets are less than its liabilities or
it is obviously incapable of paying off its debts.
APPLICATION TO COURT
Bankruptcy proceedings are commenced in
the People’s Court in which the enterprise is
domiciled and can be initiated by either the
debtor or its creditors. If the debtor is a financial
institution, the court application shall be filed
by the relevant regulatory authorities under the
State Council.
APPOINTMENT OF AN ADMINISTRATOR
Upon acceptance of the bankruptcy application,
the court appoints a bankruptcy administrator
who may be a member of recognised legal,
accounting or specialist bankruptcy firms,
or possess relevant professional expertise
and qualifications. The mode of selecting
an administrator and his remuneration is
determined by the Supreme People’s Court.
The administrator reports to the People’s Court
and is supervised by the creditors’ meeting and
the creditors’ committee. The creditors’ meeting
has the ability to replace the administrator or
to seek his removal should he fail in performing
his duties in a lawful and impartial manner,
or if the creditors’ meeting deems there
are circumstances that prevent him from
performing his duties competently.
The administrator’s powers and duties include:
ƒƒ Taking control of the debtor’s property,
company seals, accounting records,
documents and other such materials;
ƒƒ Investigating and reporting on the debtor’s
financial status;
ƒƒ Making decisions in relation to the debtor’s
internal management and daily expenditure;
ƒƒ Deciding whether to continue or suspend the
debtor’s business operations prior to the first
creditors’ meeting;
ƒƒ Managing and disposing of the debtor’s
property;
ƒƒ Representing the debtor in litigation,
arbitration or other proceedings;
ƒƒ Proposing the holding of creditors’ meetings;
and
ƒƒ Performing other functions that may be
required by the court.
An administrator who fails to act with due
diligence and care and to faithfully perform
his duties could face a fine or personal liability
if found to have caused loss to a creditor, the
debtor or a third party.
CREDITORS’ CLAIMS
Creditors are required to file their claims
within a time period stipulated by the People’s
Court. Such period commences from the
date of publication by the People’s Court of
the announcement of its acceptance of the
bankruptcy petition and runs for a minimum of
30 days and a maximum of three months.
Major eligible claims include:
ƒƒ Debts that exist at the time of the court’s
acceptance of the application for bankruptcy;
ƒƒ Unmatured debts;
ƒƒ Conditional debts or debts subject to time
limits;
ƒƒ Claims pending litigation or arbitration;
ƒƒ Debts owed to joint creditors;
ƒƒ Indemnity obligations owed to a guarantor
of the debtor or to another joint debtor who
has discharged a debt on the behalf of the
debtor; and
ƒƒ Damages under a contract terminated by
the administrator or the debtor under the
provisions of the Bankruptcy Law.
CREDITORS’ MEETINGS
Creditors may participate in the bankruptcy
process through creditors’ meetings and the
creditors’ committee.
A creditor who has submitted a claim in the
bankruptcy is entitled to attend and vote
at the creditors’ meeting (save for secured
creditors who cannot vote on the adoption of
a settlement plan or distribution plan of the
debtor’s assets unless they have waived their
right to priority). However, a creditor whose
claim has not been determined may not exercise
voting rights except that the People’s Court
can provisionally determine the amount of his
claim for the purpose of allowing him to vote.
Generally, a resolution of the creditors’ meeting
is passed by a simple majority of the creditors
with voting rights present at the meeting and a
majority representing 50% or more of the value
of the debtor’s unsecured debt.
The creditors’ meeting may:
ƒƒ Verify creditors’ claims;
ƒƒ Apply with the court to replace or remove
the administrator;
ƒƒ Supervise the administrator;
ƒƒ Select members of the creditors’ committee;
ƒƒ Determine whether to continue or suspend
the debtor’s business operations;
ƒƒ Approve restructuring plans and settlement
agreements;
ƒƒ Approve plans to manage, realize and
distribute the debtor’s property; or
ƒƒ Perform other functions that the court
requires.
CREDITORS’ COMMITTEE
The creditors’ meeting may establish a
creditors’ committee that comprises creditor
representatives elected by the creditors’
meeting. The composition of the creditors’
committee, which totals not more than nine
people and must include a representative of
the debtor’s employees or a representative of
its trade union, is subject to the approval of
the People’s Court in writing. The creditors’
committee is responsible for supervising the
management, disposal and distribution of the
debtor’s property, proposing the convening of
creditors’ meetings and such other duties as
may be delegated by the creditors’ meeting.
CREDITORS’ RIGHT TO SET-OFF
Creditors who incurred debts to the debtor prior
to the court’s acceptance of the bankruptcy
application may request the administrator
to set off their debts against their claims.
However, set-off is not permitted if the creditor
incurred the debt with knowledge of the
debtor’s inability to repay its debts unless the
debt was incurred more than one year prior
to the application for bankruptcy or is due by
operation of law.
COUNTERPARTIES TO CONTRACTS
Contracts entered into before the acceptance
of the bankruptcy application but not yet fully
performed can be terminated or continued
by the administrator. The administrator is
required to notify the counterparty of his
decision within two months of the acceptance
of the bankruptcy application or 30 days after
receiving a reminder from the counterparty.
Failure to do so deems the contract to be
terminated. If the administrator decides to
continue a contract, the counterparty is entitled
to request the administrator to provide a
guarantee. A failure to provide the guarantee
also deems the contract to be terminated. If a
contract is terminated in accordance with the
legislation, the counterparty may file its claim
on the basis of its right to claim damages as a
result of the termination.
PRIORITY AND RANKING OF DEBTS
The Bankruptcy Law sets out a hierarchy of debts to
determine priority of payment, which must be made
in the following order:
ƒƒ Bankruptcy expenses;
ƒƒ Common interest debts (i.e. certain debts incurred
after the court accepts the bankruptcy petition);
ƒƒ Employee claims, including unpaid salaries,
medical and disability subsidies, basic old-age and
medical insurance premiums, and compensation
in accordance with PRC law;
ƒƒ Social insurance premiums and outstanding tax;
and
ƒƒ Common (unsecured) claims in bankruptcy.
If the property in bankruptcy is insufficient to
satisfy the discharge requirements of a certain
rank of debts, the distribution to such rank shall be
effected on a pro rata basis.
Secured creditors generally have priority to the
extent of the value of their secured properties while
any shortfall is to be treated as an unsecured claim.
However, employee claims accrued prior to the
promulgation of the Bankruptcy Law on 27 August
2006 will continue to enjoy their right (under the
previous law) to priority over secured creditors.
Restructuring and Settlement
An important feature of the regime is the availability
of rescue options within the formal process to
restructure or rehabilitate viable businesses.
Although the court may have accepted a bankruptcy
application, the Bankruptcy Law allows a debtor or
its creditors the opportunity prior to an enterprise
being declared bankrupt to apply with the court
for restructuring or Reorganization of its business.
The legislation also allows a debtor to apply for
a compromise or settlement of its debts with its
creditors.
RESTRUCTURING PROCEDURE
Prior to the enterprise being declared bankrupt, the
debtor or its creditors can apply with the People’s
Court for restructuring. The debtor or administrator
must submit a draft restructuring plan to the court
and the creditors’ meeting within six months (with
an extension of three months if approved by the
court) of the court’s ruling for restructuring. During
the restructuring period, the debtor can apply for
court approval to continue to manage its properties
and business under the administrator’s supervision.
Creditors are classified into the following
voting groups:
ƒƒ Creditors with secured claims over specific
properties of the debtor;
ƒƒ Employees with claims on salaries, medical
and disability subsidies, basic old-age
and medical insurance premiums, and
compensation payable into the individual
accounts of employees in accordance with
PRC law;
ƒƒ Claims on outstanding taxes; and
ƒƒ Common (unsecured) claims.
Upon receipt of the draft restructuring plan,
the court convenes a creditors’ meeting within
30 days to vote on the draft plan. The draft
plan must be approved by a majority of the
number of creditors in each voting group, and
the amount of claims they represent must
account for at least two-thirds of the total
amount of claims in that group. If the draft
restructuring plan is not approved by all of the
voting groups, the debtor or the administrator
can still apply with the court for approval
if certain conditions are satisfied. If the
restructuring plan is not approved, the court
terminates the restructuring and declares the
debtor bankrupt.
The debtor is responsible for the
implementation of the restructuring plan.
A supervision period is imposed by the
court, during which time the administrator
is required to supervise the implementation
process and the debtor must report to the
administrator. If the debtor is unable or fails
to implement the restructuring plan, the court
terminates the restructuring plan and declares
the debtor bankrupt upon petition from the
administrator or a materially interested party.
During the restructuring period, the court
has additional powers to terminate the
restructuring plan and declare the debtor
bankrupt if:
ƒƒ The debtor’s business operation or financial
status continues to deteriorate and cannot
be salvaged;
ƒƒ The debtor has acted fraudulently,
diminishes its assets in bad faith or has
acted in a way adverse to the creditors; or
ƒƒ The administrator is unable to perform
his duties and functions as a result of the
debtor’s actions. Secured creditors’ rights
over pledged assets are suspended during
the restructuring period. If there is a risk of
damage to the secured asset or of significant
diminution in its value such that the secured
creditors’ rights are prejudiced, the secured
creditor may apply with the People’s Court to
enforce its rights. Once the restructuring plan
is approved by the court, it is binding on the
debtor and all of the creditors.
SETTLEMENT PROCEDURE
Settlement allows the debtor to compromise
its debts directly with its creditors after the
bankruptcy proceedings have commenced.
It requires an application by the debtor
accompanied by a draft settlement agreement.
If the court approves the settlement application,
it will make an announcement and convene
a creditors’ meeting. Secured creditors may
exercise their security rights from the date the
court approves the settlement.
Once the settlement plan is approved by
the creditors’ meeting and the court, the
administrator is obliged to transfer the business
and assets to the debtor. For the plan to become
effective, it must be approved by more than
half of the creditors with voting rights present
at the meeting. The claims represented by such
creditors must account for at least two-thirds
of the total amount of unsecured claims. If the
settlement plan is rejected at the creditors’
meeting or by the court, the court will declare
the debtor bankrupt.
A settlement agreement that has been
approved is binding upon the debtor and the
creditors covered by the settlement, i.e. the
creditors who held an unsecured claim against
the debtor at the time the court accepted the
bankruptcy petition. If the debtor is unable or
fails to implement the settlement agreement,
the court, upon the request of a creditor
covered by the settlement, terminates the
implementation of the settlement agreement
and declares the debtor bankrupt.
Asset recovery
MORATORIUM
A moratorium is imposed on the debtor’s
assets upon acceptance of the bankruptcy
application by the court. Upon acceptance of
the bankruptcy application, all preservation
measures against the debtor’s property are
lifted and all enforcement actions suspended.
Civil actions or arbitration procedures that
have commenced against the debtor but not
completed are stayed. Any repayment of debts
to a creditor during this period is deemed
invalid.
Collection and realization of assets
The debtor is obliged to deliver up its property
to the administrator after the court accepts the
bankruptcy application. The administrator has
a duty to get in all the property of the debtor
and to prepare asset realisation and distribution
plans that are submitted at the creditors’
meeting for approval. Unless resolved otherwise
at the creditors’ meeting, the administrator is
obliged to dispose of the debtor’s property in
the bankruptcy by way of auction. Property that
cannot be auctioned off or whose transfer is
restricted by state regulations shall be disposed
of by those state regulations.
Voidable transactions
The administrator has the power to investigate
and claw back questionable transactions.
The administrator is able to petition the People’s
Court to revoke transactions entered into within
one year preceding the court’s acceptance of the
bankruptcy application as follows:
ƒƒ Transfers of property for no consideration;
ƒƒ Transactions carried out at markedly
unreasonable prices;
ƒƒ Provision of security for unsecured debts;
ƒƒ Premature settlement of undue debts; and
ƒƒ Renouncement of creditors’ claims.
Likewise, the administrator can recover debts
that have been repaid to individual creditors
within six months prior to the acceptance of the
bankruptcy petition except where the debtor
has benefited from such a repayment.
Any transactions that conceal or transfer assets for the purpose of avoiding liabilities,
or which fabricate debts or acknowledge a fictitious debt, are deemed invalid by the
Bankruptcy Law.

RECOVERY FROM DIRECTORS AND OFFICERS

The administrator is able to recover any irregular income or assets misappropriated from
the debtor by its directors, supervisors or senior management using their authority.
Directors and officers may also face civil liability if breach of their duties of honesty and
diligence resulted in the debtor’s bankruptcy. After bankruptcy proceedings are finished,
if they are found to be liable, they will be disqualified from being an office-holder of
any enterprise for three years.

Cross-border insolvency
Bankruptcy proceedings commenced in the PRC pursuant to the Bankruptcy Law
cover not only the debtor’s assets in the PRC but also extend to its overseas assets.
The legislation also recognises foreign bankruptcy proceedings involving assets in the
PRC so as to allow execution in the PRC provided:
ƒƒ There are relevant reciprocal treaties between the PRC and the foreign country;
ƒƒ The foreign bankruptcy proceedings do not contravene the laws, sovereignty,
security, social and public interests of the PRC; and
ƒƒ The legal interests of creditors in the PRC are not prejudiced.
Out-of-Court mechanisms
Although the legislation lays down a framework
for restructuring and settlement within the formal Contacts
bankruptcy process, it is possible for entities to adopt
Kwun Yee Cheung
informal measures not involving the court. Informal
Partner, Hong Kong
work-outs or similar options may be an alternative to
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those parties seeking greater control of the restructuring
process and not wishing to be restricted by the kwun.yee.chung@

requirements under the legislation. bakermckenzie.com

In the past, when business enterprises were largely Haifeng Li

state-owned, the rehabilitation of ailing businesses was Partner, Beijing
a process directed by the state. As businesses evolved to +86 10 6535 3867
include private and foreign interests, the restructuring of
haifeng.li@
an enterprise would have required the approval of, and
bakermckenzie.com
coordination between, the relevant stakeholders.

Accordingly, as in other jurisdictions, the success of an

informal rescue plan in China depends much upon the
agreement and cooperation between the various factions
that, in the case of China, may involve state interests.

Conclusions and additional observations

China’s bankruptcy legislation encapsulates many
concepts familiar to other jurisdictions.

While the current framework of the Bankruptcy Law

requires refinement, the law is considered to be a major
development for China and provides investors with a
unified and comprehensive insolvency regime.
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